How the Deductibility of PPP Related Expenses is Impacted by Latest IRS Guidance on PPP Loan Forgiveness

Updated 12/4/2020 at 11:50 AM ET

SC&H’s Key Takeaways

  • The cancellation of your PPP loan does not result in taxable income.
  • Expenses paid with PPP loan proceeds are not deductible to the extent your PPP loan is forgiven.
  • Separately track your PPP related expenses in your accounting ledger as non-deductible expenses and reconcile these expenses once your loan is forgiven.

The Internal Revenue Code (IRC) states that the discharge of indebtedness results in taxable income to the borrowing taxpayer. However, the CARES Act specifically excludes PPP loan forgiveness from taxable income. That’s great for borrowers, but it throws another wrinkle into the tax equation.

IRC Section 265

Under Internal Revenue Code (“IRC”) Section 265, expenses that are allocable to tax-exempt income are not deductible. Accountants across the country have been waiting with bated breath for someone to provide guidance on whether IRC Section 265 is applicable to PPP related expense, or if they will be specifically excluded. Well, the wait is over.

IRS Notice 2020-32

On April 29, 2020, the IRS ruled on the matter and issued IRS Notice 2020-32. The notice plainly states the that:

“No deduction is allowed under the Internal Revenue Code for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a covered loan pursuant to section 1106(b) of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act)…and the income associated with the forgiveness is excluded from gross income for purposes of the Code pursuant to section 1106(i) of the CARES Act.”

Since the CARES Act does not specifically exclude PPP related expenses from IRC Section 265, the Section is fully applicable, and the expenses are not deductible. This section serves to prevent the taxpayer from receiving a double tax benefit: tax-free income and allocable tax-deductible expenses. It makes sense, but it’s a shift in the stated benefit that Congress provided in the CARES Act.  We are hearing that the Senate Finance Committee is looking into reversing the impact of this notice, but for now, this is the answer.

Some perhaps unintended consequences:

  • What if some of the PPP loan forgiveness you enjoy is from a retirement plan contribution you make in 2020 during your 24-week PPP covered period, but the deduction was taken on your 2019 return? Same question for rent, utility and interest payments deducted in 2019 but paid in 2020 if PPP forgiveness is computed on a cash payment basis?
  • What if you must capitalize some of the loan forgiveness expenses under IRC 263A? What about wage limitations under 199A?
  • What impact would there be on R&D credits, which are based upon wages primarily?  State apportionment factors could be impacted as well.
  • What if some of the rent expense is subject to IRC 467, how are those calculations impacted?
  • If the IRS notice is overturned, will states decouple from the federal tax-free treatment of PPP loan forgiveness?

December 4, 2020 Update

The IRS issued another notice on this topic in November that confirms that they believe PPP-related expenses are not deductible.

Of note:

  • Revenue Ruling 2020-27 states that the loss of deductions occurs in the year in which the taxpayer reasonably believes their PPP loan will be forgiven.
  • This is true whether or not the PPP borrower has applied for or received forgiveness from either their PPP lender or the SBA
  • If in 2021 some or all of the PPP loan is not forgiven or is repaid, the taxpayer may elect to take forgone deductions in 2021 or amend their 2020 returns under Revenue Procedure 2020-51.

So, what now?

Expenses that can be used for PPP loan forgiveness include 24-weeks’ worth of payroll costs, interest on mortgage obligations, rent, and utilities. If your goal is loan forgiveness, you should record these in your accounting ledger separately as non-deductible expenses. Once, you receive forgiveness, you may need to make a reconciling entry to adjust the non-deductible amount to match the amount forgiven.

At the writing of this blog, Congress is mulling over a stimulus package that would once again allow PPP-related expenses.

If you have any questions or would to speak with one of our team members, please don’t hesitate to reach out. SC&H is here to help.